Why All Financial Systems Run Out Of Steam

We can and must change the name of our financial game to serve ourselves.

I was prompted to write this missive after seeing another feeble financial construct bite the dust, as reported by the Financial Times.

Only 16 hedge funds “were able” to deliver positive returns before fees in 2018 from a universe of 450 monitored by HSBC’s alternative investment group – this not to mention those completely shuttered in 2018. Clearly, all winners were on the other side of these trades! BlackRock = 19.9% loss last year on its BSF European Diversified Equity Absolute Return fund; The $1bn GAM Systematic Cantab quantitative fund = 23.1% lost; and Zurich-based Entrepreneur Partners’ €79m Trias L/S fund, which invests in German, Austrian and Swiss equities, lost 26.9 per cent – its second annual loss in the past three years.

The cancer

This abominable result, no doubt affecting asset managers who, with anxious members breathing down their neck, are trying, for the life of them, to produce multi-asset allocation strategies yielding returns above 7%.

Private equity, on the whole, is not performing consistently any better, with pension funds, like CalPERS and OMERS, now tempted to go “direct” to avoid lofty managerial expenses. Not a smart strategy. Venture capital, for the last twenty years, with the inverse risk profile embedded in private equity, has failed to arbitrate viable access to an 80% greenfield of innovation adoption, with its collusion now yielding a debilitating subprime theory that restricts rather than expands the future that can be discovered. With no innovation in real estate sector to speak of, according to a 20-year money manager in that class, asset managers are now stumped by what musical chair they must jump onto to eke out viable repeatable returns.

Depravity of reason galore

Now, the thing to do when you wish to remain a financier is to hold your ground and to compare your performance to an index, short or long, whichever floats your boat. Not unlike kids in school comparing grades when none in their class scored anywhere close to a B, leaving responsible parents understandably aghast. Also, not unlike the incestuous and equally meaningless references to the top quartile, when absolute returns are missing.

Another popular way to fend off any suspicion or contention is to refer to finance as innately cyclical. Relying on the notion that finance, eleven times the size of production, betting on itself and correlated to its own spiral of subprime performance, indeed produces the cyclicality of a downward spiral with ever debilitating and narrowing purview of valuations portrayed as value.

The reason why we classify the above as depravity of reason is that the pursuit of building better financial performance is currently merely correlated to avoiding consequence, not to address the causal reasons as to why financial systems fail. Nietzsche, in the early 1900s, cleverly identifying a confounding of consequence and cause, widespread amongst followers, as grave depravity of reason.

Put differently; you do not cure a disease by putting more bandaids on it, nor by waiting for a supposed cyclicality of health to occur, for the latter may include death. Like a doctor, you instead attempt to discover the causal reason for the failures in finance and pursue a higher normalization of truth that plagues all of finance, albeit in perhaps different stages of gross inequities and urgency.

The cause

The reason why financial “systems” fail is that they perform much like horse-races, and in fact, fail because they are not systems at all. The way they are constructed can never yield predictability, in the same way, a horse race cannot.

In summary: few betting on horses today quite understands the nature or pedigree of the horses (cause), and the odds of betting on a winning horse are calculated by gamblers mainly on what horses won the race before (consequence). Resistant to new entrants, the betting coagulates around the few horses similar to the ones that have ever won a race, deflating winnings while reducing the opportunity for new outliers to reinvigorate the playing field.

For finance to produce consistent and repeatable returns, it must match and inherit the evolutionary principles of the investible asset. With most investible assets in finance derived from the production value of people, the evolutionary principles of humanity must, therefore, be inherited by finance to reap the reward of a dynamic composition of human ingenuity and capacity. Indeed, the name of the game of finance must change as the name of the game, and risk, of production changes.

Say what?

Simply put, the systems of finance must inherit the evolutionary principles of production. Evolutionary principles honed to perfection over 4.5 billion years. Some 4.5 billion years, give or take before we humanoids arrived on the scene.

Meaning, in summary:

  1. Finance must abide by the rules of renewal, not held hostage by a false presumption of sustainability nonexistent anywhere in our universe.
  2. Finance must abide by a relativity theory of freedom that establishes and promotes a dynamic meritocracy of premium socioeconomic value, not be beholden by stale absolutisms from an expiring past.
  3. Finance must assign risk to meet the nature of collective perpetual humanitarian needs, not to the temporal vile-maxims of selfish wants.

So, the simple reason why our financial “systems” fail systemically is that they are incompatible with the assets to which they are applied.

Now, the hall pass I give finance is due to our government not having established the rule of the game that must be played to serve the evolution of its constituents. In its current form, woefully unable to deploy the optimal mobility of diverse merit to renew society. It is incredibly worrisome I still need to explain to government candidates why a proper definition and implementation of freedom is paramount to a vibrant society. Even more embarrassing, I had to reiterate the same points to sitting members of Congress as well.

Sporting opportunity

The opportunity for finance is not unlike the opportunity to build a new league in sports, a phenomenal financial proposition in its own right, that “happens” to also explore the consistency of growth in humanitarian gameplay we wish to see.

You see, finance as an industry, or large firms like BlackRock and KKR, or even large pension-funds like CalPERS can deploy the equivalent of a new sports league in which the rules of the game are not left unguarded by our government, asleep of the wheel of creative destruction, but are purpose-driven to improve the excellence of humanity. With players of the game accepting and in conformance to the evolutionary rules of the game, we enjoy watching from the bleachers.

Come

Change does not come from a government engrossed in navel staring or applying band-aids to undesirable consequences. Change comes from us in finance leading by example and demonstrating we understand that our future is not protected by us becoming the wealthiest people in the cemetery. But, that we – for the first time – build systems of finance that explore and produce returns commensurate with the expanding fractal of human ingenuity, and to improve the lives and opportunity for our children and their offspring. We owe it to them to deploy our intelligence to build better systems of finance than the nihilistic constructs we inherited, used, and abused.

Do not hesitate to contact me if you are eager to learn how.

 

 

Join Georges October 27-29 in London, at the 2021 Climate Change Forum.

Let’s lead the world by example with new rigors of excellence we first and successfully apply to ourselves.

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